Cost of reproduction method.

According to Rev. Proc. 77-12, the cost of reproduction method is appropriate for determining the value of inventory readily replaceable in a wholesale or retail business, but generally not useful for establishing the value of the finished goods of a manufacturing concern. Other factors are relevant when inventory is valued using this method. For example, the FMV of a well-balanced inventory available to fill customer orders may exceed its reproduction cost, because it provides a continuity of business while the value of obsolete inventory may be less than its reproduction cost.

In Knapp King-Size Corp., 527 F2d 1392 (1975), the Court of Claims ruled that the FMV of a catalog business's inventory on the date of its distribution in a Sec. 334(b)(2) liquidation was its adjusted replacement cost. The court calculated the inventory's adjusted replacement cost by deducting disposition costs and an allowance for the profit a willing buyer would expect from the inventory's aggregate retail catalog prices. The court concluded that this value represented the price a hypothetical willing seller would expect as compensation for the inventory's current replacement cost and a fair return for accumulating and preparing a well-balanced inventory for distribution. The method the court used to calculate the inventory's adjusted replacement cost was actually the comparative sales method, but the court noted that this method should arrive at the inventory's adjusted replacement cost if correctly applied.

Editor: Wilfred H. Heitritter, CPA, J.D. Executive Partner -- Tax McGladrey & Pullen LLP San Bernardino, CA